PSNC 2014: One-Size-Fits-All?

At the PLANSPONSOR National Conference in Chicago, four leading experts debated the merits of target-date funds (TDFs) versus target-risk funds (TRFs) and managed accounts.

These experts started with the question of what is the best way to deliver asset-allocation options to participants.

“It’s important to make sure they are used effectively by participants, which means adopting the best practices of pension plans,” said Scott Brooks, managing director of the institutional group at SEI Investments. “Twenty years ago, many pension plans managed to benchmarks completely ignorant of liability. The defined contribution [DC] liability is the same: the provision of retirement income for participants.” Thus, Brooks said, “whether it’s a TDF, TRF or a managed account—any of these are a good solution.” Secondly, the institutionalization of a portfolio is key, he said, because “fees do matter.”

Thirdly, the offering should be “something the participant understands,” Brooks continued. “Yesterday Elaine [Sarsynski, EVP of MassMutual Retirement Services Division] said the average participant spends seven minutes on the enrollment survey. Properly allocating assets needs to be done for them.”

Craig Keim, vice president, director of defined contribution investment relationship management at T. Rowe Price Retirement Plan Services, agreed: “Any asset allocation solution is better than what the participant can do on their own with a core menu, even if it is a robust, streamlined core menu.” Next, Keim said, plan sponsors should consider “cost and participant involvement. These frame the question of which is better.”

Then, to figure out which fund is the right one, look at the Department of Labor guidance on target-date funds, Keim suggested. “It starts with analyzing plan goals, be they capital preservation, taking participants through retirement, the risks the sponsor is trying to mitigate. Market risk? Longevity risk? Do you offer a DB [defined benefit] plan along your DC plan? If the fund is the QDIA [qualified default investment alternative], then it has different ramifications.

Glenn Dial, head of U.S. retirement at Allianz Global Investors added, “DC plans have replaced DB plans. It’s tough when you think about picking the right TDF with the tools we have today. What did the DB plan do? It gave participants a pretty certain expectation of the income they could expect at retirement. So ask, ‘How do I get the most participants to an adequate retirement income replacement ratio?’”

That doesn’t factor in savings rates, noted Natan Voris, large market practice leader at Morningstar Investment Management. “Retirement readiness is what we are trying to do,” Voris said. “TDFs don’t control savings rates. We all know the best solution is for participants to meet with a financial planner once a year, but we all know that isn’t going to happen. So the asset-allocation choice should consider not just retirement age, as TDFs do, but also risk tolerance. Therefore, the next step is managed accounts charging 10 to 12 basis points that can offer a customized solution for participants. That is the optimal investment solution.”

A member of the audience then challenged Voris about the lack of a track record on managed accounts, and how this inevitably results in investment committees selecting off-the-shelf solutions for fear of fiduciary liabilities. Voris said that Morningstar always produces backward-looking data for the consumption of the committee, but not for the participants. “We have to provide all the data, all the research,” he said.

Dial agreed that customization is the future for asset-allocation solutions. “We are in the third inning of a nine-inning baseball game,” he said. “We will continue to see evolution in this space. We think custom TDFs will continue to grow and come down market.” Combined with the growing trend to increase savings rates, Dial said, this will have “a tremendous impact on the type of TDF you should offer. They will probably become like managed accounts with prices at institutional levels.”

Voris agreed that the industry is moving toward more customization, predicting that “the gap between TDFs and custom managed accounts will close and include holistic advice on reducing debt” in order to boost participants’ savings rates and retirement readiness.

Further, Voris said, as asset allocation offerings will continue to mimic more and more DB characteristics, they will include specialty funds, such as real estate funds and emerging markets—but not in the core menu.

If the plan sponsor has selected a TDF, they should assess it like a DB plan, Brooks said. “Select best-in-class managers and consistently review them,” he said. “Select an asset allocation target that has the highest probability of reaching your plan’s goal, and using a tactical approach for a portion of the portfolio is a key piece of the puzzle.”

As to participants’ acceptance of asset allocation offerings as the automatically enrolled QDIA, even after steep market drops and volatility, 90% of participants do not opt out, Keim noted. “We then look at the opt-out rate one to two years after the enrollment or re-enrollment in the fund, and see that it is still as high as 75% to 80%,” Keim said, which would suggest that participants like having their money professionally managed for them.